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Nicholas Piramal: Avecia deal dissected!

Nov 9, 2005

Nicholas Piramal recently announced the acquisition of Avecia Pharmaceuticals, a UK based company, for a consideration of GBP 9.5 m (approx. Rs 763 m). In this article, we take a look at the terms of the acquisition and whatís in it for Nicholas Piramal.
About Nicholas Piramal
Nicholas Piramal is one of the leading Indian pharma companies with strong focus in the domestic market. It is the fourth largest pharma company with 4.3% share (FY05) of the domestic market and a large sales force covering 10 therapeutic segments. The company has started focusing on the exports market too and the contribution of exports in total sales has increased to 12% from zero in the space of three years. It has gradually improved its product portfolio by increasing the share of lifestyle drugs and has also started focusing on R&D off late. The biggest contributor to companyís revenue is the respiratory and cardiovascular segment. The other major therapeutic segments in which the company operates are anti-infectives, nutritional and gastro intestinal.

About Avecia Pharmaceuticals, UK
Avecia Pharmaceuticals is a global custom manufacturing player focused on providing custom chemical synthesis and manufacturing services for the innovator pharmaceutical and biotechnology companies. It is part of the UK based Avecia Group. It had consolidated sales of GBP 36.1 m (Rs. 2.9 bn) in 2004. The business includes early/late-stage and launched manufacturing drugs in UK and North America, a deep pipeline of products backed by strong customer relationships and a mix of unique technologies. The company comprises of three business entities, which are Avecia Pharmaceuticals, UK, Torcan Chemical, Canada and a 25% ownership of Reaxa Ltd, Manchester, UK.

Terms of the deal
The salient features of the deal are as follows:

Nicholas will pay a total consideration of GBP 9.5 m (Rs 763 m) and will acquire Avecia on a share purchase basis. This includes 100% equity of Avecia Pharmaceuticals, UK, 100% equity of Torcan Chemical, Canada and 25% equity of Reaxa Ltd, Manchester, UK.

Nicholas will own all the assets of Avecia Pharmaceuticals and Torcan Chemical, including working capital of GBP 8.8 m (Rs 707 m). Avecia Group will, however, fund the UK pension fund deficit of GBP 8 m to 9 m (approx. Rs 722 m).

The global custom-manufacturing scenario

The size of the global custom manufacturing industry is pegged at US$ 15 bn and has so far been dominated by players in the US and Europe. However, these companies lately have been facing increasing challenges. While the new drug pipeline of global innovator companies has been on the decline since the turn of the century, a large number of their existing drugs are facing threats of patent expiry. Against this, while R&D expenditure has been on a steep upward trend, pressure on the government to reduce healthcare costs has also been weighing heavily on these innovator companies. As a result, in a bid to cut down on costs, many of these companies are most likely to switch over to Indian custom manufacturing companies, which enjoy significant low cost advantage. The generics segment has already witnessed a substantial shift in terms of outsourcing from Indian players.

Whatís in it for Nicholas?

Nicholas Piramalís acquisition strategy is built around custom manufacturing and thus the Avecia acquisition is in line with this strategy. It must be noted that the companyís contract manufacturing strategy is different from that of Cipla. While Cipla has secured tie-ups with generic companies like Ivax, Watson, Mylan and Barr, Nicholas is aiming to tie-up with innovator companies. Custom manufacturing entails targeting potential innovator companies as customers and building long-term relationships with them. The process involves time and it could be a while before the contracts actually start generating revenues.

This is where Avecia fits in. Avecia Pharmaceuticals has a strong presence in the North American and European markets. More importantly, it has relationships with 5 of the top 10 innovator companies and several medium-sized pharma and biotech companies. This will be a big positive for Nicholas in strengthening its custom manufacturing business going forward as it will enable the company to gain access to Aveciaís clientele.

Besides this, the merger will also enable Nicholas to gain access to technologies in chiral synthesis, fermentation and biotransformation. With this merger, Nicholas Piramal is aiming to synergize its manufacturing sites, integrate the sales force into a unified team and also over a period of time enter new market segments and launch new products. Thus we believe that this acquisition will augur well for the company from a long-term perspective. It must be noted that Nicholas Piramalís current export sales do not include any custom manufacturing turnover.

What to expect?
At the current price of Rs 267, the stock is trading at a price to earnings multiple of 25.9 times our estimated FY08 earnings, which is at the higher end of our valuation spectrum. We believe that contract manufacturing, though in its initial stages, is likely to be a key growth driver for the company going forward. In this regard, the company has secured two agreements (one with a Fortune 500 company and the other with Allergan Inc., US). The company also expects to sign five new, long-term custom manufacturing contracts by the end of November 2005. However, it will take around two years for these contracts to start generating revenues. Post the product patent regime, the company has initiated steps on the R&D front with its oncology molecule commencing Phase I clinical trials in Canada. However, we believe that the company is unlikely to introduce any patented products of its own over the next 3 to 4 years.

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